Tax reform can aid multinationals, cut deficit

July 7th, 2013

July 7, 2013

Imagine a library where many books have been borrowed and are long overdue. There is a case for an amnesty to get the books back and move on. There is a case for saying that rules are rules and fines must be paid. But the worst strategy is to keep indicating that an amnesty may come soon without ever introducing it. And this is roughly where we are in our corporate tax debate.

No one is satisfied with the U.S. corporate tax system. Some argue the main problem is that, while corporate profits are extraordinarily high relative to gross domestic product, tax collections are relatively low. Many very successful companies pay little or nothing in taxes at a time when the budget deficit is a major concern, hundreds of thousands of defense workers are being furloughed and lotteries are being held to determine which children Head Start can no longer afford to help.

But others say the main problem is that the United States has a higher corporate tax rate than any other major country and, unlike other countries, imposes severe taxes on income earned outside its borders. This, they argue, unfairly burdens companies engaged in international competition and discourages the repatriation of profits earned abroad. The resulting patterns of investment are also said to benefit foreign workers at the expense of their U.S. counterparts.

With respect to tax reform, these perspectives seem to argue in opposite directions. The former points toward the desirability of raising revenue by closing loopholes; the latter seems to call for a reduction in corporate tax burdens. But while many can get behind the idea of “broadening the base and lowering the rate,” consensus tends to collapse over the means to broaden the base. A principal objective of many business-oriented reformers seems to be narrowing the corporate tax base by reducing the taxation of foreign earnings through movement to a territorial system.

Despite the tension between perspectives, the debate has landed us in so perverse a place that win-win reform would be easy to achieve. The central issue is the taxation of global companies. Under current law, U.S. companies are taxed on their foreign profits — with a credit for taxes paid to other governments — only when they repatriate these profits. Right now, U.S. companies are holding nearly $2 trillion in cash abroad. Businesses argue, with some validity, that current rules make it expensive to bring money home while not raising much revenue for the government. Tax relief, they assert, would help them bring money home, at a minimum benefiting their shareholders but also possibly leading to an increase in investment.

Critics counter that companies that have used what might politely be called aggressive accounting practices to locate income in low-tax jurisdictions should not be given further relief.

In the meantime, what’s a corporate treasurer to do? With the possibility of some kind of relief looming, there is every reason to delay repatriating earnings to the United States even if the company has no good use for the cash abroad. And so the debate encourages exactly what all sides can agree is desirable to avoid: corporate cash kept abroad to the detriment of companies and to no benefit for the U.S. fiscal situation.

A clear and unambiguous commitment that there will be no rate reduction or repatriation relief for the next decade would be an improvement over the current situation because companies would know that they will have to pay taxes on their foreign profits if they wish to make them available to shareholders and would no longer have an incentive to delay.

But this would not be the best outcome. As a very general rule, improvement is possible anytime tax rules are experienced by taxpayers as a substantial burden without generating substantial revenue for the government. Having taxpayers be burdened less and pay more can make them better off and help the fiscal situation. The United States should eliminate the distinction between repatriated and unrepatriated foreign corporate profits for U.S. companies and tax all foreign income (after allowances for taxes paid to other governments) at a fixed rate well below its current corporate rate, perhaps in the range of 15 percent.

A similar tax should be imposed on past accumulated profits held abroad.

Such a proposal could easily be designed to raise revenue relative to the current baseline, encourage the repatriation of funds and reduce the competitive disadvantage faced by U.S. multinationals operating abroad. It is about as close to a free lunch as tax reformers will ever get.

Lawrence H. Summers is the Charles W. Eliot University Professor and President Emeritus at Harvard University. He served as the 71st Secretary of the Treasury for President Clinton and the Director of the National Economic Council for President Obama.